Climate resilience and sustainable finance: will Cinderella go to the ball?

Climate resilience – or adaptation – has been referred to as the Cinderella of climate action. Is it time for her to go to the sustainable finance ball?

We’ve seen important progress in the mainstreaming of physical climate risk information into financial decision-making over recent years. In 2017, the TCFD recommendations created space for information about physical climate risks – and also related opportunities – in climate-related financial disclosures. This was advanced further through the 2021 TCFD guidance on metrics, targets and transition plans, and has now been mainstreamed into the 2022 ISSB draft guidance on climate-related disclosures. As a result, there is now more information available about how financial and non-financial firms are affected by physical climate risks, with the TCFD’s 2022 Status Report finding that 21% of asset managers and 36% of asset owners were reporting their exposure to physical climate risk. Ratings agencies have internalised physical climate risk information into their credit rating methodologies, and a range of service providers and open-source platforms on physical climate risk information have emerged. Furthermore, financial supervisors in a number of jurisdictions have integrated physical climate information into their supervisory requirements on climate-related risk disclosure, for example the ECB, the Bank of England, as well as international bodies such as the NGFS and the Basel Committee on Banking Supervision.

This is good news for market action on climate resilience – also referred to as adaptation. Robust information on physical climate risks is the foundation stone for managing those risks, and for building resilience to them. But there is a kind of asymmetry in the information flows available to investors at present. Investors are now getting some information on reasons not to invest because of exposure to physical climate risks but are getting much less information on reasons to invest because of the potential to contribute positively towards building climate resilience. In fact, more information about physical climate risks in the absence of complementary information about the positive contributions of investments towards climate resilience could even drive finance away from where it is most needed. This is sometimes referred to as capital flight – raising the cost or capital for climate-vulnerable sectors or countries, for example small island developing countries. This contradicts the need for significantly scaled-up investment in climate resilience investment, which the United Nations estimate as up to USD 340 billion per year by 2030.

Regulatory frameworks for sustainable finance have evolved significantly in recent years – but what potential is there for these to facilitate greater investment in climate resilience? To date, sustainable finance has focused principally on decarbonisation, based on the logic that capital should be driven towards addressing the root cause of climate change by reducing GHG emissions. But the emerging sustainable finance architecture also has the potential to address the other climate change imperative – the need to cope with the inevitable impacts of climate change. These will be significant even under a 1.5^oC scenario, with the European Environment Agency estimating adaptation finance needs of EUR 40 billion per year under a 1.5^oC scenario in Europe alone. Climate resilience features prominently in the EU Sustainable Finance Taxonomy, which identifies adaptation as one of its six sustainability objectives. However, the role of climate resilience in the application of the EU Taxonomy appears to be limited to a do no significant harm function only. There is very little evidence of sustainable finance being defined on the basis of a substantial contribution to adaptation. In fact, the EU’s Platform on Sustainable Finance has recently pointed out that urgently needed adaptation investments may be disincentivised by the way that the Taxonomy requires users to select one sustainability objective only, which is usually mitigation due to the overwhelming market interest in decarbonisation. Other building blocks of the EU sustainable finance approach, such as the Sustainable Finance Disclosure Regulation (SFDR) and the Corporate Sustainability Reporting Directive (CSDR), fail to provide clear entry points for climate resilience as a basis for defining sustainable finance or reporting corporate action on sustainability.

So what are the ways in which the momentum on sustainable finance can also advance urgently needed action on climate resilience?

Firstly, recognise that climate resilience and decarbonisation objectives are not in opposition to each other, but can be and should be aligned. Advancing climate resilience does not mean diluting ambition to stay under 1.5^oC. Significant investment in climate resilience will be needed even under a 1.5^oC scenario, but the more that we overshoot 1.5^oC, the greater still those climate resilience investment needs will be.

Secondly, make space for climate resilience in sustainable finance definitions and labels. Investments that make meaningful contributions towards addressing physical climate risks and building the resilience of people, nature or the wider economy should be able to be identified as sustainable investments – with clear safeguards in place to eliminate greenwashing and ensure that other sustainability objectives, including decarbonisation, are respected. For instance, it will be interesting to see whether climate resilience will be considered under the sustainable impact label that is being considered under the UK’s proposed Sustainability Disclosure Requirements.

Thirdly, develop and build consensus around clear, understandable, and consistent impact metrics that investors can use to assess the contribution that investments make towards climate resilience. Together with the rapidly expanding availability of physical climate risk information, these could help to inform capital allocation that supports climate resilience goals. These metrics should be developed with clear reference to the evolving regulatory context for sustainable finance, to ensure relevance and usefulness for as wide a range of investors as possible.

Climate resilience is sometimes referred to as the Cinderella of climate finance – dutifully clearing up in the background, while her louder and pushier sisters hog the limelight. But with climate change impacts already affecting the lives of millions, and the need for scaled up investment in climate resilience no longer a distant prospect, it’s an issue that can no longer be sidelined in the sustainable finance discussion. It’s time for Cinderella to go to the ball.